Even after two interest rate cuts by the Raghuram Rajan-led RBI, except for State Bank of India, other state owned banks are yet to announce any reduction in their lending rates.

Even after two interest rate cuts by the Raghuram Rajan-led RBI, except for State Bank of India, other state owned banks are yet to announce any reduction in their lending rates. (Reuters)

For India’s Central bank, the government and more importantly borrowers, it’s been frustrating. Much after inflation inched down — way below the projected trajectory of the Reserve Bank of India — and two interest rate cuts by the RBI, by 25 basis point each time since the start of the year, most local lenders have been unmoved.

That was enough for RBI Governor, Raghuram Rajan to indulge in some plain speaking: “I do not see an environment where credit growth is tepid; banks are sitting on money so to speak and their cost of funding, their marginal cost of funding has fallen, the notion that it has not fallen is nonsense.” That appears to have prompted SBI and ICICI Bank to lower rates hours later but most banks are still unmoved.

But is this tough talk by the RBI enough to bring down EMIs and boost demand? Are more rate cuts needed to ensure a rebound in growth? It does seem so. A Deutsche Bank report says, “retail inflation has fallen 400 basis points in the last 12 months, and will likely ease further in FY16, while RBI has not even cut the policy rate to the level (7.25 per cent) that prevailed before the currency crisis erupted in mid-2013. Clearly if the RBI wants its monetary action to help accelerate the investment recovery, more rate cuts would be required and that too in a front loaded manner.”

Except for State Bank of India, other state owned banks are yet to announce any reduction in their lending rates. For instance, the base rate — or the rate below which these banks cannot lend — of PSU banks like Punjab National Bank and Central Bank of India is still 10.25 per cent. The benchmark prime lending rate of Central Bank is at a high of 15 per cent. “The impact of reduction in cost of deposit experienced during the last quarter will encourage banks to pass on the benefit to customers,” said VR Iyer, chairperson & managing director, Bank of India.

But banks, too, have defended their stance. On April 7, soon after the RBI announced a status quo monetary policy, chairman of State Bank of India, Arundhati Bhattacharya, defended the delay on the part of banks in transmitting the policy rate cuts to customers saying, “it takes a little time for things to pass through … there are very many factors and repo is only one of the factors.” However, later in the day it cut its base rate to 9.85 per cent and subsequently slashed home loan rates. SBI was followed by rate cuts by ICICI Bank, HDFC Bank, Axis Bank and other small private banks.

SBI’s home loan rate is pegged at 9.85 per cent (for women), leading to a reduction in EMI to Rs 867 per lakh while the interest rate for Central Bank of India’s Cent Home Loan scheme is 10.25 per cent.

WHY BANKS ARE RELUCTANT?

The big question is: Why are banks so hesitant to bring down lending rates? The reasons are structural — some of them self-inflicted — which can’t just be wished away overnight. “Benefits of easier monetary policy have yet to reach the real economy. Banks remain hesitant to lend due to worries over asset quality, uncertain demand recovery, lack of clarity over upcoming cuts and availability of alternate funding options,” said Radhika Rao, economist, DBS Bank.

Another major hurdle is poor asset quality of PSU banks. Banks’ gross non-performing assets (NPAs) increased to 4.5 per cent of advances at the end of December 31, 2014 from 4.2 per cent on September 30, 2014. While the gross NPA percentage crossed 5 per cent for PSU banks, for private banks it was marginally up at 2.1 per cent. Many corporates, especially in the infrastructure sector, are over leveraged and have defaulted on loans taken from PSU banks. A cursory look at the balance sheets of such defaulters reveals that banks went on extending loans even after their debts mounted. Neither the RBI or the government appear to have stepped in earlier.

There’s a view that aggressive rate cuts would lift lending. If history is any indication, this is not the case. According to bankers, during the last easing cycle between January 2012 and mid-2013, the base rate fell by a modest 40 basis points despite a lowering of rates by over 100 bps- both repo rate and cash reserve ratio.

Bankers say the shift by corporates from bank-based funding has added to slow loan growth, which in turn has failed to spur lenders to slash rates. “Corporates have increasingly resorted to bond issuances or commercial papers to meet funding needs. Money market borrowing costs are 100-150 bps lower than banks’ base rates. Varied tenor needs are being fulfilled by the central bank’s push for longer-term papers,” Rao said.

Rao says the shift is likely permanent. The RBI itself has proposed that part of the corporates’ capital needs to be raised from bond and commercial paper markets to lower dependence on banks. This is already in motion as banks’ share in corporate borrowings has eased from about 100 per cent in 2004-05 to 60 per cent in 2011-12, while non-bank sources inched up to about a third, she says.

What’s the way forward? Stronger demand, supportive fiscal policy and redressal of the banks’ stressed assets are probably required to boost lending. However, this appears to be a long-drawn process for banks weighed down by huge bad debts.